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Shuze Liu: Theory of the Firm (Perfect Competition (EX:) (Assumptions…
Shuze Liu: Theory of the Firm
Perfect Competition (EX:)
Limitations
Does not provide much choices that consumers would like to choose from, as goods are identical.
Does not incentivize firms to invest in additional research and improve quality of goods, as firms are making only normal profit in the long run.
Large numbers of firms is bad for achieving economy of scale, as each firm gets too little a share from the revenue generated in the market to purchase mass production machines.
Economies and Diseconomies of Scale in Long Run (all fixed costs become variable costs):
Ecomony of Scale: when quantity is small, each additional instance of factor of production brings more and more marginal output.
(Due to capability to purchase mass production machines)
Disecomony of Scale: when quantity is great, each additional instance of factor of production brings less and less marginal output.
(Due to incapability of overseeing the production process by one person)
Constant returns to scale: each additional instance of factor of production brings the same marginal output. Occurs between the intervals of economy of scale and diseconomy of scale.
Assumptions
Free entry and exit of firms (no barriers of entry)
Perfect Information among the consumers (they know the prices given by all firms)
Large Number of Firms
Goods are identical
Law of Diminishing Marginal Return in Short Run (There are fixed and variable costs):
Fixed resources fixed;
When when quantity is small, each additional instance of factor of production brings more and more marginal output. Due to specialization of workers)
Then as quantity continues to increase, each additional instance of factor of production brings less and less marginal output all the way to negative.
(Due to too many workers operating on fixed resources and interfering with each other's tasks)
Total Cost Curves in short run:
Total Cost = Variable Cost + Fixed Costs
TC=VC+FC
Curvature of TC and VC curves are due to sunk costs for first entry and increasing and diminishing marginal returns.
Profit Maximazation: the goal of all firms is to maximize economic profit.
Increase market share (firm wants to control the good's market)
Social concerns (EX: environmental and ethical concerns, especially for NGOs)
Profit satisficing for investors (satisfy investors to let them willing to invest more)
Maximize accountant profit (earn more money)
Marginal and Average Cost Curves:
D=AR=MR=P
S=MC
ATC=AVC+AFC
MC intersects with AVC and ATC at their lowest point
MC, AVC, and ATC are upside-down bell curves due to increasing and diminishing makrgian returns.
AFC keeps decreasing as the fixed cost is distributed to more quantities of the good
Supernormal Profit: P>ATC (Economic profit >0, only possible in the short run; as in the long run. other firms would enter the market, forcing the price to decrease)
Normal Profit: minimum economic profit a firm needs to earn to saty in the market. (In perfect competition market, Normal Profit = Breakeven Point)
Breakeven Point: P=ATC (Economic profit = 0, firm should keep on producing)
Shutdown Point: P=AVC (firm considers shut down, becase at this point, all its total revenue is used to cover variable costs; in other words, there is no difference in producing or not producing goods to the firm.)
Sunk Costs: costs that cannot be recovered by altering production plans
(EX: researching funding, tuition)
(Should not be considered when making future decisions, but most people don't have enough rationality to enbrance this principle)
Closest Examples to Perfect Competition
Flea Market: Same as agricultral market.
Online Market: people can see alternative firms producing the same goods also in the search bar.
Agricultural Market: products are nearly identical as long as it is the same crop, and firms are densely packed for consumers to compare.
Foreign Exchange Market: people would see lots of firms that exchange currency in the same place.